Issues Covered in this Section:
A. Legislation that impacts the Form 990-T and the Form 990
B. The redesigned Form 990, return of organization exempt from income tax
C. Filing requirements regarding foreign corporations
D. Reporting issues related to the Pension Protection Act (PPA)
E. Reporting issues not related to the Pension Protection Act
F. Form 5550
The Tax Exempt & Government Entities Subgroup (TE/GE Subgroup) addresses the needs of three very distinct customer segments: Employee Plans, Exempt Organizations, and Government Entities. The customers range from small local community organizations and municipalities to major universities, huge pension funds, state governments, Indian tribal governments and participants of complex tax exempt bond transactions.
During 2007 the TE/GE Subgroup consulted with Mark O’Donnell and Roger Kuehnle of the Employee Plans group area on the information reporting challenges the Pension Protection Act of 2006 brought to pension plans. We discussed the Internal Revenue Service Form 5500-EZ with Joyce Kahn and Schedule SSA with Ann Junkins of the Service as well as others from the Social Security Administration. Lastly, we worked with Michael Seto, Ron Schultz and Theresa Pattera and others from the Exempt Organization group to discuss various topics that impact the exempt organizations and government entities. These topics included clarification of certain provisions of recent tax legislation; changes and other implications to the Form 990, Return of Organization Exempt from Income Tax; and filing requirements regarding foreign corporations, including the Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund and Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation.
The TE/GE Subgroup would like to extend our sincere gratitude to all the individuals with whom we worked this past year. Their openness and support allowed us to truly work as a collaborative team.
II. ISSUES AND RECOMMENDATIONS
A. Legislation that Impacts the Form 990-T and the Form 990
The IRS has responded in an official manner on a timely basis to requests made by the TE/GE subgroup regarding recent legislation that impacts the filing requirements for exempt organizations and governmental entities.
Public Disclosure of Form 990-T, Exempt Organization Business Income Tax Return:
With the enactment of the Pension Protection Act of 2006 (PPA), Congress imposed a new requirement on all organizations exempt from federal income tax under IRC Section 501(a) and described in IRC Section 501(c)(3) to make available for public inspection a copy of any annual return filed under IRC Section 6011 relating to tax imposed under IRC Section 511. Thus, these exempt organizations must disclose to the public their tax returns, the Form 990-T.
The question arose, however, whether state colleges and universities are subject to this new law. Although the income derived by state universities is excluded under IRC Section 115 rather than IRC Section 501(a), they file the Form 990-T as required under IRC Section 511 and perform similar to private schools that are subject to this new law.
With the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), Congress designated certain transactions as prohibited tax shelter transactions, and imposed excise taxes on exempt organizations and, possibly, their managers, when they participate in these transactions. Subsequently, the IRS revised the form 990 to require the exempt organization to indicate whether it was a party to such a transaction during the year. Accordingly, the exempt organization community sought more guidance on the definition of a prohibited tax shelter transaction.
Recommendations and Discussion:
Form 990-T, Exempt Organization Business Income Tax Return:
The TE/GE subgroup recommended that the IRS provide some guidance to the higher education community as to whether state institutions are subject to the new disclosure rule regarding their Forms 990-T.
The IRS issued this year Notice 2007-45 that provides, among other things, guidance with respect to this disclosure rule. Those state universities that file the Form 990-T but have not been recognized as exempt under IRC Section 501(a) are excluded from this disclosure requirement. However, those state institutions that exclude income under IRC Section 115 and have received recognition as exempt under IRC Section 501(a) are required to disclose this tax form.
Form 990, Return of Organization Exempt from Income Tax:
The TE/GE subgroup recommended that the IRS provide guidance to exempt organizations when they are considered to have participated in a prohibited transaction.
The IRS issued this year Notice 2007-18 that provides, among other things, guidance with respect to the term “party to a prohibited transaction.” An exempt organization is a party to such a transaction if (1) it facilitates the transaction by reason of its exemption, indifferent or tax-favored status, or (2) the transaction is identified as a prohibited tax shelter transaction. This notice also gives examples.
Benefits to IRS and Taxpayer:
This guidance should serve to promote better compliance from the exempt organizations and governmental entities with respect to their disclosure and filing requirements.
B. The Redesigned Form 990, Return of Organization Exempt from Income Tax:
In reaction to statements from Congress and as part of an internal initiative to revise the form 990, the IRS has significantly redesigned its Form 990 by requiring additional information. Highlights of the redesigned draft can be found here. The IRS anticipates this redesigned form to be available for filing for the 2008 tax year (returns filed in 2009).
In cooperation with public interest groups, this subgroup put forth verbal recommendations on the redesigned form in general as well as submitted written recommendations on the Schedule A, Supplemental Information for Organizations Exempt Under Section 501(c)(3), Schedule H, Hospitals, and Schedule K, Supplemental Information on Tax-Exempt Bonds.
Due to the voluminous information requested with the redesigned form, the objectives are to provide comments that provide for thresholds and certain transitions as a means to capture the essential information without unduly burdening the taxpayer. Also, it is in the best interest of all parties if the form requests critical information in the correct format.
Recommendations in general are the following:
a. Define the term review in Part III, line 10, that requests whether the organization’s governing body reviewed this form prior to filing. Review may include delegated authority as well as direct involvement;
b. Define the term substantial in Part VII, line 8b, that requests whether the organization conducted a substantial part of its exempt activities through a partnership, LLC or corporation. The IRC provisions relating to exempt organizations define substantial anywhere from 2% to 85%;
c. Reduce the number of years required to report endowment funds in Schedule D, Part XII as it relates to Part VII, line 6, for the past four years to include only the current and prior year. The prior year returns include this information, thus, this modification will avoid restating the same information;
d. Define the term donor in Schedule F, line 5a, that asks whether any grantee is related to any person with an interest in the organization, including a donor. Note that charitable organizations receive numerous small donations from individuals and businesses without considering them as having an interest in the organization;
e. Increase the threshold with respect to organizations that may file the Form 990-EZ.
Recommendation on Schedule A regarding supplemental information for charities, is the following:
a. The TE/GE subgroup recommends that the IRS include in the instructions a provision that allows charitable organizations that file as public charities under Part II to compute the test on either the cash or accrual basis. Note that the current Form 990 (not the redesigned draft) requires charitable organizations to compute this test on a cash basis only. This redesigned Form 990 makes no reference to this cash basis requirement and it is assumed that the charitable organization may compute this test using either method; however, specific reference in the instructions will highlight this change for those filers.
b. Previously, the accrual basis charitable organization was required to convert contributions from individual donors to a cash basis in order to complete this test, requiring a high administrative burden that is not justified by precedential authority, compelling reasons, or best business practices. The rationale was simply to assist small charitable organizations that keep their accounting records on the cash basis. Accordingly, this recommendation should assist and accommodate the large as well as the small charitable organization.
c. As evidence of the large taxpayers who rely on this test to maintain their public charity status, this subgroup submitted to the IRS a file that included at least 20 large charitable organizations that file the Schedule A using this test. The term large corporation is defined as an organization that uses the accrual basis accounting method with revenues ranging from $25 million to $3.5 billion.
Recommendations on Schedule H regarding hospitals include the following:
a. Consider making available to the hospitals the instructions, definitions and worksheets prior to the 2008 year. The information that hospitals are required to report includes the entire year and without appropriate guidance, the information reported may be inaccurate and incomplete. Alternatively, consider a postponement in reporting this schedule until the information is available.
b. Include Medicare payments as part of community benefit in Part 1 on the grounds that these payments function similar to Medicaid payments. To the extent that they differ, consider a discount factor to apply accordingly.
c. Include the cost of patient care bad debt as part of community benefit to the extent that it covers low-income patients and can be tracked as a separate cost to the organization. Consider a discount factor, if appropriate.
Recommendations on the Schedule K are the following:
a. Include a question on record retention practices in an effort to assess the integrity of managing bonds.
b. Include a question that asks whether the issuer has filed the Form 8038-T, Arbitrage Rebate, Reduction and Penalty in Lieu of Arbitrage Rebate, as required by the IRC, and, if not, whether it met an exception.
c. Consolidate the private use questions into one general question that asks whether each bond complies with these restrictions appropriately. The current questions can mislead a bond holder or credit agency into thinking that a bond has lost its exemption when, in fact, it has not since these questions fail, taken together, to address compliance as a whole.
d. Reduce the information requested in Parts I and II to changes that have occurred with respect to outstanding bonds rather than re-stating much of the information provided in the prior year returns.
Benefits to IRS, the Taxpayer and the General Public
This guidance should serve to promote better compliance and transparency from the nonprofit community with respect to how it operates and benefits the general public.
The IRS will further evaluate these recommendations for the upcoming year.
C. Filing Requirements Regarding Foreign Corporations:
With the recent attractiveness of foreign investments to investment brokers and management firms, many nonprofit organizations with modest to large endowments find as a matter of consequence that they are subject to foreign filing requirements which can be burdensome and overwhelming, resulting in attaching an excessive number of forms to their annual income tax returns. This increased burden has lead exempt organizations to question whether, due to their exempt nature, these forms apply to them and, if so, exactly how to file the forms completely and accurately.
Form 8621 - Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund:
a. This form subjects to taxation a U.S. person who invests in passive foreign investment companies (PFICs), i.e. foreign corporations which generate primarily passive income. The rationale is to prevent a perceived abuse whereby a U.S. person could defer taxes on the foreign fund’s earnings and obtain capital gains treatment when the gains were realized by redeeming the stock.
b. The form includes three taxation regimes under the PFIC provisions: (1) the excess distribution regime that imposes an interest charge on excess distributions from PFICs; (2) the qualified electing fund (QEF) regime, if the U.S. investor so elects, that follows the rules similar to those for controlled foreign corporations; and (3) a third regime that allows the holders of marketable stock in a PFIC to make a Mark-to-Market election on an annual basis.
c. Exempt organizations, however, are generally excluded from taxation on dividends paid by corporations, including foreign corporations, and on gains derived from sales of capital assets, including stock. The notable exception is when the investment property is debt-leveraged, in which case, the dividend paid is subject to unrelated business income tax (UBIT) under the debt-financed rules. Accordingly, based on these UBIT provisions, investments in PFICs which are not debt-financed do not trigger taxation under any of these regimes and, thus, by logic, should be excluded from filing this form.
d. The instructions, however, do not address this threshold issue, and, in fact, as written, leave the nonprofit organization in doubt as to whether it must file the form.
Form 926 - Return by a U.S. Transferor of Property to a Foreign Corporation:
a. IRC Section 6038B, Notice of Certain Transfers to Foreign Persons, provides that “each U.S. person who transfers property to a foreign corporation in an exchange described in section 332, 351, 354, 355, 356, or 361, … shall furnish to the Secretary, at such time and in such manner as the Secretary shall by regulations prescribe, such information with respect to such exchange or distribution as the Secretary may require in such regulations”.
b. These IRC provisions do not necessarily apply to exempt organizations. For instance, when an exempt organization establishes taxable subsidiaries, the tax consequences are not analyzed under the non-recognition provision of IRC Section 351. In fact, the instructions to Part III confirm this position. Under this part, question 10, the taxpayer is required to describe the type of non-recognition transaction it conducted, and the instructions list only the IRC provisions mentioned above without any reference to the UBIT rules.
c. The Treasury regulations and instructions do not give clear guidance on this threshold issue, leaving the nonprofit organization in doubt as to whether it must file the form and, if so, how to complete Part III.
Form 8621 - Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund:
The TE/GE subgroup recommends that the IRS clarify whether and, if so, under what circumstances, exempt organizations are required to file this form.
The instructions reference exempt organizations by tax regimes, but do not make it clear as to whether and when this form, taken as a whole, should be filed. For instance, under the first tax regime, it states that the tax and interest rules of IRC Section 1291 apply only if the dividend from the PFIC is taxable to the exempt organization under Subchapter F, Exempt Organizations. Whereas with the election regime, the instructions provide that the exempt organizations that are not taxable under Section 1291, may not make the election. Accordingly, although technically correct, these detailed instructions without any overall guidance have given some exempt organizations the impression that they may have a filing responsibility with respect to this form. Yet, clearly, based on the form’s rationale and the UBIT provisions, this filing requirement seems unnecessary.
Form 926 - Return by a U.S. Transferor of Property to a Foreign Corporation:
The TE/GE subgroup recommends that the IRS clarify whether exempt organizations are required to file this form and, if so, how to complete Part III.
The Treasury regulations and the form instructions reference exempt organizations when discussing exceptions to filing this form, implying that but for this circumstance, they must file accordingly. The Treasury Regulations 1.6038B-1(b)(2)(A)(2) and (B)(2) and form instructions exclude exempt organizations from filing this form when transferring stock or securities under Section 367(a) when the exempt entity is the transferor and the income is not UBTI.
Although these regulations and instructions give the impression that exempt organizations may have a filing responsibility with respect to this form, based on a strict interpretation of the statute, this filing requirement does not appear to apply.
Benefit to IRS
Clarification regarding these threshold filings should serve to promote better compliance with exempt organizations as to their filing requirements and, if excluded from filing, will further contribute to its paper reduction initiative.
Benefit to the Taxpayer
Such guidance should help exempt organizations to file accurate and complete tax returns and, if excluded from filing, will reduce their administrative burdens.
The IRS will further evaluate these recommendations for the upcoming year.
A. REPORTING ISSUES RELATED TO THE PENSION PROTECTION ACT (PPA)
On August 17, 2006, President Bush signed the Pension Protection Act of 2006 (PPA) into law. The Act contains many significant provisions relative to qualified plans, 403(b) accounts, government sponsored 457 plans, IRA accounts and certain tax-exempt entities. While the primary focus of the Act was on improving the funding viability of defined benefit plans, many provisions in the Act bring about changes for defined contribution plans, such as 401(k) plans, and for Individual Retirement Accounts (IRAs).
The focus of this report will be the expansion of certain rollover and distribution opportunities with regard to employer sponsored plans and IRAs that were brought about by PPA. The reporting issues associated with these transactions have been identified and discussed by the TE/GE Subgroup and are outlined below. A total of six different distribution/rollover situations are being addressed in this report along with the issue of reporting distributions of “erroneous automatic contributions” made pursuant to an automatic enrollment program. [Note, for purposes of this discussion, the term “qualified plan” will refer to plans under section 401(a), 403(a), 403(b) and government 457 plans, as applicable. In addition, all references to the Form 1099-R Instructions refer to the 2007 version of these instructions.]
Reporting Issues With Regard to Certain Rollovers:
The following distribution/rollover reporting issues should be added to or clarified in the Form 1099-R instructions as indicated below:
a. Distributions from designated Roth accounts to participants:
Distributions from non-qualified designated Roth accounts are reported with Code B in box 7 of Form 1099-R. For distributions that are not being directly rolled over, the Instructions do not address whether the 20% withholding applies to the earnings portion of the distribution. Confirmation of this withholding requirement is requested. A discussion of the 20% withholding and reporting requirement should be added to the instructions for: “Designated Roth account distributions” and “Designated Roth account” discussions respectively on page R-7; and to the section entitled “Eligible rollover distribution: 20% withholding” on page R-8 and the discussion of the direct rollover requirements on page R-3.
b. Direct rollovers from designated Roth accounts to Roth IRAs or other eligible plans by participants:
Presumably this transaction would be coded as BG in box 7 of Form 1099-R since this code combination is apparently allowed but there is no confirmation of this code combination usage in the Form 1099-R instructions. Such guidance is needed to insure proper and consistent reporting among employer payers. Such guidance should be inserted on page R-3 of the Instructions under “Reporting a direct rollover” or under “Designated Roth Accounts” or both. Either a new sentence could be added at the bottom of the first paragraph in either (or both) sections or a separate new paragraph discussing the reporting scheme could be added. An additional sentence could also be added to the discussion of code G on page R-12.
Alternatively and in consideration of Item (e) below, a new code could be assigned to direct rollovers of designated Roth account distributions. Doing so appears necessary to avoid having to use a three-digit code in box 7 to indicate direct rollovers from designated Roth accounts to Roth IRAs by non-spouse beneficiaries as it was confirmed by the IRS Forms and Publications division that a three-digit code combination is not possible. Accordingly, Code H should be considered for this purpose. Code H is a retired distribution code that was previously used to designate a direct rollover from a qualified plan to an IRA. Code H was eventually retired when it was no longer necessary to distinguish whether the rollover recipient was an IRA or another qualified plan. Payer systems may still carry code H on an inactive basis in their IT systems such that it might not be as much of a hardship to reactivate it as it would be to program for a new distribution code altogether.
c. Direct and indirect rollovers to Roth IRAs, effective beginning 2008:
In the case of a direct or indirect rollover of a non-Roth distribution from an employer sponsored plan to a Roth IRA, the taxable portion of the distribution would be taxable to the participant in the year the distribution occurs. The direct or indirect rollover to a Roth IRA should not in any way affect the otherwise taxable status of the distribution. Reporting recommendations in this regard are as follows:
1. Reporting direct rollovers to Roth IRAs:
The gross distribution amount should be reported in box 1 on Form 1099-R and the taxable amount should be reported in box 2a; as opposed to entering zero as is normally the case when a code G is used. Code G would be placed in box 7 to indicate that the distribution was directly rolled over to a Roth IRA. The unique reporting combination of a taxable amount appearing in box 2a and a code G in box 7 would indicate that the distribution was taxable in the year received and rolled over to a Roth IRA. The Roth IRA Custodian would report the amount received as a rollover in box 2 of Form 5498 and the participant would treat the amount as basis in the Roth IRA. In addition, the participant would report the rollover on a Form 8606, which should be revised for this purpose.
2. Reporting indirect rollovers to Roth IRAs:
The distribution would be reported in the same manner as other eligible rollover distributions that are not directly rolled over by plan participants; e.g. a code 1, a 7 or a 4 would be entered in box 7; instead of a code G. In addition, 20% of the taxable portion of the distribution would be withheld and reported in box 4 of Form 1099-R just as it is now for other eligible rollover distributions not directly rolled over. If the participant later decides to roll over the distribution to a Roth IRA, the Roth IRA custodian would report the amount received as a rollover contribution in box 2 of Form 5498 and the amount would subsequently be treated by the participant as basis in the Roth IRA. The participant would also need to report the rollover on a Form 8606, which should be revised for this purpose as noted above.
It is also recommended that the Form 1099-R instructions include explicit guidance as to the reporting of direct rollovers to Roth IRAs by plan sponsors and the reporting of indirect rollovers to Roth IRAs by Roth IRA custodians in the appropriate places in the Form 1099-R Instructions.
d. Direct rollovers of distributions to Inherited IRAs by non-spouse beneficiaries:
While it is assumed that rollovers of non-Roth distributions to Inherited IRAs are to be reported using the combination of codes G and 4, the Form 1099-R instructions do not currently address these reporting requirements. It is recommended that the reporting requirements be specifically addressed: on page R-3 under “Reporting a direct rollover,” preferably as a new separate paragraph under that subsection; on page R-6 under “Beneficiaries”; and on page R-12 in the discussion of code G.
e. Direct rollovers from designated Roth accounts to Inherited Roth IRAs by non-spouse beneficiaries:
In the opinion of the TE/GE Subgroup, there is nothing in the applicable section of PPA that would preclude application of the non-spouse rollover option to designated Roth account distributions. Therefore, it is recommended that the reporting of such direct rollover transactions be explicitly addressed in the Form 1099-R Instructions. To this end, since a three-digit code, such as BG4, is not programmatically possible for the IRS, it is recommended that a combination of a new Code H and 4 be used in box 7. (See Item (b) above for the code H discussion). It is also recommended that the issue of rollovers of designated Roth accounts to Roth IRAs be addressed in the Form 1099-R instructions in the form of a new paragraph in the subsection entitled “Designated Roth accounts” on page R-3 and in the subsection entitled “Designated Roth account” on page R-7.
f. Direct rollovers of eligible rollover distributions to Inherited Roth IRAs by non-spouse beneficiaries:
It is recommended that direct rollovers of non-Roth amounts by non-spouse beneficiaries to Roth IRAs be reported in the same manner as such rollovers by participants, as described above in Item (c), except that the combination of codes G4 would be used in box 7. Under current law, an indirect rollover to an IRA (or Roth IRA) by a non-spouse beneficiary is not permitted.
Distributions of Erroneous Automatic Contributions Within 90 Days:
The Form 1099-R instructions should include the following reporting guidance. The erroneous automatic contribution amount being returned plus attributable earnings would be reported as fully taxable in box 2a of Form 1099-R (to the extent the contribution amount is not a Designated Roth contribution). In box 7, a numeric combination of 2 and 8 could be used to designate that the distribution is a return of an erroneous automatic contribution that is taxable in the year distributed and that it is not subject to the 10% premature penalty. In addition, any amounts returned within six months of the close of the plan year that are in excess due to the failure of the actual deferral percentage (ADP) or actual contribution percentage (ACP) test, could also be reported in this manner. The sections entitled “Corrective Distributions” appearing on pages R-4 and R-5 would need to be revised to reflect this special treatment as would the section on “Failing the ADP or ACP Test After a Total Distribution” on page R-5. It is also recommended that a new paragraph be drafted to describe erroneous automatic contributions and that it be inserted after the section entitled “Excess deferrals.” The sections entitled “Excess Contributions” and “Excess Aggregate Contributions” on page R-5 would also need to be revised to reflect the special treatment for the return of excess contributions and excess aggregate contributions within six months after the close of the plan year.
Guidance was also sought on how investment losses on erroneous automatic contributions should be handled; e.g. would the plan or employer plan sponsor be responsible for making the employee whole for investment losses or would such losses not have to be made up? It is recommended that the plan not be forced to make up investment losses as to require same would have an inequitable impact on the plan accounts of the other plan participants and further it could put the employer plan sponsor in the position of having to make non-deductible contributions to the plan. It is further recommended, if the employer plan sponsor is required to make up the loss through payroll, that this amount be reported as additional compensation (wages, salaries, tips) on Form W-2.
Clarification as to whether distributions of erroneous automatic contributions would be reported on Form 1099-R or on Form W-2 was sought from the IRS. It was recommended by the TE/GE Subgroup that reporting of these distributions be performed on Form 1099-R in order to assure consistency with the reporting requirements applicable to comparable “excess” deferrals and contributions and because of the presence of earnings. It would be a potential hardship for plan administrators and confusing for affected participants to have the wage adjustment reported on Form W-2 but the earnings attributable to the returned deferrals reported on Form 1099-R. In addition, since the returned deferrals plus earnings are taxable in the year distributed, this would cause particular confusion for participants to the extent the return takes place in the year following the year in which the compensation being returned was earned and otherwise taxable; i.e., the return in the subsequent year, if reported on Form W-2 would serve to misrepresent the actual compensation earned and deferred in that subsequent year.
Benefit to Payers
The TE/GE Subgroup believes that for all the items addressed above, the benefit to payers is the existence of needed guidance which will enable accurate and consistent reporting compliance and relieve the burden of reporting uncertainty.
Benefit to IRS
The TE/GE Subgroup believes that the provision, or expansion and clarification of reporting guidance for these PPA items would greatly enhance operational and reporting compliance and, as a result, would generate timely, consistent and accurate reporting among sponsoring employers and IRA custodians alike. Such enabled compliance could help insure the proper reporting and collection of the appropriate tax revenue.
Benefit to Taxpayers
The TE/GE Subgroup believes that plan sponsors and affected employees want to comply with their reporting obligations and pay the proper taxes due, as applicable. If there were clear, concise and consistent guidance available on how to accurately report these rollover and distribution transactions and how to treat them from a tax perspective, the subgroup strongly believes that both plan sponsors and affected employees would be in a better position to comply with their respective reporting and any associated tax payment obligations.
B. REPORTING ISSUES NOT RELATED TO THE PENSION PROTECTION ACT (PPA):
This report focuses on the prospective reporting requirements governing miscellaneous transactions that affect Individual Retirement Account (IRA) holders and IRA custodians alike. Two of the issues arose as a result of the passage of two separate laws in 2006; the Tax Increase Prevention and Reconciliation Act of 2005, (TIPRA) and the Tax Relief and Health Care Act of 2006 respectively. The third issue addressed in this report is one that has been addressed in prior years’ TE/GE Subgroup Public Reports but unfortunately remains unresolved. The backgrounds for the three issues addressed are as follows. [Note: all references to the Form 1099-R instructions refer to the 2007 version of these Instructions.]
Eligibility, treatment and reporting of conversions from traditional IRAs to Roth IRAs and of Direct Rollover Distributions from Employer plans to Roth IRAs. Section 824 of the Pension Protection Act of 2006 amended Code Section 408A(e) to allow for direct rollovers from qualified plans, §403(b) accounts and §457(b) governmental plans to Roth IRAs effective beginning 2008. Code Section 408A(c)(3) was amended to impose on such rollovers from employer sponsored plans, the same income restrictions applicable to conversions from IRAs to Roth IRAs, e.g. Adjusted Gross Income (AGI) not in excess of $100,000. TIPRA as passed in May of 2006, amended Code Section 408A(c)(3) to eliminate the income restriction currently contained in Code Section 408A(c)(3), effective beginning 2010, meaning the restriction will no longer apply as of that date. Amounts that are converted from IRAs and/or rolled over from employer sponsored plan from plans to Roth IRAs beginning in 2008 are includable in taxable income in the year distributed to the extent the amount exceeds after tax basis.
Reporting of rollovers from IRA accounts to Health Savings Accounts (HSAs), effective beginning 2007. Effective for years beginning in 2007 and thereafter, an eligible individual with an HSA account can take a one-time distribution from his or her IRA and directly roll it over to an HSA account as a contribution. The standard HSA contribution limits apply. An exception to the once in a lifetime rollover/contribution restriction is available if an eligible individual’s coverage status changes from individual to family in which case, the eligible individual would have the opportunity to execute another IRA rollover to an HSA account. Only taxable amounts can be rolled over in this manner.
Reporting of corrections of excess SEP and SIMPLE contributions. Simplified Employee Pension plans (SEP plans) and Salary Reduction Simplified Employee Pension Plans (SARSEP plans) and Savings Incentive Match Plans for Employees Plans (SIMPLE IRA Plans) are plans that are primarily adopted by small businesses, including self-employed individuals, other non-incorporated businesses and small corporations. Except in the case of SARSEP plans that by law cannot be adopted after December 31, 1996, the adoption and employee coverage of these plans has grown tremendously. With growth comes the need for detailed operational and reporting compliance guidance. While some operational and reporting compliance guidance regarding the correction of excess deferrals and excess contributions can be found for SARSEP IRA plans in the IRS Form 1099-R instructions, no such guidance is included in the Form 1099-R instructions for the correction of excess contributions to SEP IRA accounts or excess contributions or deferrals to SIMPLE IRA accounts.
Recommendations for eligibility, treatment and reporting of Conversions from Traditional IRAs to Roth IRAs and of Direct Rollover Distributions from Employer plans to Roth IRAs.
Several discussions took place on this topic, however it will be a carry-over item for 2008 as no guidance has been issued as of this writing.
Recommendations for the Reporting of Rollovers from IRA accounts to HSA accounts.
The TE/GE Subgroup recommends that the IRS add a few sentences to the subsection entitled “IRAs Other than Roth IRAs,” which appears on page R-2 under the section of the Form 1099-R instructions entitled “IRA Distributions” in order to specifically address the reporting of one-time distributions from IRA accounts that are directly rolled over to HSA accounts. Likewise it is recommended that no special distribution coding be required for an IRA to HSA rollover transaction; i.e. the transaction is to be reported by IRA custodians as normal (code 7) or premature (code 1), whichever is applicable. Finally, it is recommended that the IRS add a discussion to the Form 1040 instructions for line 15 of the Form that details how a taxpayer is to report an IRA to HSA rollover transaction on his or her Form 1040.
Recommendations for the Reporting of Corrections of Excess SEP and SIMPLE Contributions.
The TE/GE Subgroup recommends that the IRS provide explicit guidance in the instructions for Form 1099-R as to how to properly report the distribution of excess contributions, including employee deferrals as applicable, made to SEP and SIMPLE IRA plans. The logical place for such a discussion would first be an addition to the subsection entitled “Excess Deferrals” on pages R-4 and R-5 to address the correction of excess SIMPLE deferrals and next, a new section could be added entitled something to the effect of “Certain Excess Contribution Amounts Made to SEP and SIMPLE Plans” which could be inserted after the section entitled “Certain Excess Amounts Under Section 403(b) Plans” appearing on page R-5.
With regard to excess deferrals to SIMPLE IRA accounts and excess contributions to SEP and SIMPLE IRA accounts, the TE/GE Subgroup recommends that to the extent it can be demonstrated to the IRA custodian that adjusted reporting was performed by the employer or, alternatively, that the excess contribution amount will be returned to the employer, the excess contribution amount can be distributed with attributable earnings to the employee upon request, assuming the correction is taking place by the employees’ tax filing date plus extensions. The principal excess contribution amount would be reported as tax free while the earnings would be reported as taxable to the employee. To this end, in the case of a self employed person, such adjusted reporting could consist of information that no deduction was being taken for the excess amount contributed. This could also apply to the distribution of excess deferrals made to a SIMPLE IRA plan as self-employed individuals often make both types of contributions to SIMPLE IRA plan before they determine their earned income for the year.
To the extent such adjusted reporting is not to be performed by the employer and/or the excess funds are not to be returned to the employer, the excess contribution amount plus attributable earnings would be distributed to the employee upon request but the total amount would be reported as fully taxable to the employee. The same treatment would apply to the distribution of excess deferrals made to a SIMPLE IRA plan. This recommended reporting scheme approximates the corrective actions for excess SEP and SIMPLE contributions/ deferrals as outlined in Section 6.10 of Revenue Procedure (Rev Proc.) 2006-27 which pertains to the IRS Employee Resolution Compliance Resolution System (EPCRS).
Eligibility, Treatment and reporting of Conversions from Traditional IRAs to Roth IRAs and of Direct Rollover Distributions from Employer plans to Roth IRAs.
As noted above, beginning in 2010, the income limits for making conversions from Traditional IRAs to Roth IRAs and direct rollovers of eligible distributions from employer plans to Roth IRAs, will be eliminated. In addition to the expanded eligibility for conversions brought about by PPA, TIPRA allows taxpayers who convert (or roll over) in 2010 to both postpone taxation of the distribution/conversion until 2011 and spread the taxation of the conversion/ distribution over two years. Guidance is needed as to how this new income elimination and the availability of the special income tax spread rule will apply to direct rollover distributions to Roth IRAs from employer sponsored retirement plans.
Operational questions left unanswered relate to the taxation and reportability of such conversions.
Should the amount being rolled over to a Roth IRA be taxed and income tax withheld, if elected, prior to the direct rollover? If so, is the withholding subject to the 10% early withdrawal penalty just as it is in the case of a Traditional IRA conversion to a Roth IRA? If not taxed and income tax not withheld at the time of conversion, will there be separate coding to designate that the Roth account had not been taxed prior to moving the monies into a Roth IRA? Will the custodian need to keep the rolled over amount separate from the other basis in an already existing Roth IRA so as to report any subsequent distribution consisting of the rolled over amount as taxable? These are a few of the outstanding questions on treatment of this new provision.
Reporting of Rollovers from IRA accounts to Health Savings Accounts (HSAs).
The Form 1099-R Instructions currently do not contain any reference to or guidance for the reporting of one time rollovers of IRA distributions to HSA accounts, meaning the reporting of these IRA to HSA rollovers will vary from IRA Custodian to IRA Custodian and from IRA account holder to account holder. Many IRA account holders undoubtedly are expecting that IRA Custodians will report these distributions as tax free on Form 1099-R (line 2a on the form left blank) while many Custodians, absent any guidance to the contrary, may plan to report these distributions as normal or premature, as applicable. Those IRA Custodians who assume that no special distribution/rollover coding on Form 1099-R is required, will undoubtedly be confronted by upset taxpayers who demand special coding in the form of subsequent reporting corrections, to support their own reporting of these transactions as tax-free. This would particularly be the case if guidance also does not appear in the Form 1040 Instructions. Alternatively, some Custodians may assume that special IRA to HSA rollover coding is in order and apply Code G in box 7 of Form 1099-R accordingly.
The recommendation above that no special coding be required for reporting IRA to HSA is indicative of the rationale invoked by the IRS for the reporting of Qualified Charitable Distributions (QCDs); i.e. the determination of eligibility and reporting of the transaction is the exclusive responsibility of the taxpayer. Allocation of reporting responsibility to the taxpayer is also appropriate in the case of IRA to HSA rollovers because an IRA custodian would not have any knowledge of a taxpayer’s contribution eligibility or whether such a rollover transaction had already been performed at some other time, etc., and would have no means for independently obtaining or certifying such information. Any requirement to report distributions that are rolled over to HSA accounts with any special distribution code on Form 1099-R could compromise or counteract an IRA custodian’s ability and desire to report distributions accurately and with integrity. Notwithstanding, it is very important that the IRS include reporting guidance in the Form 1040 instructions to which affected taxpayers can refer and to which IRA Custodians can direct their clients who execute IRA to HSA rollovers.
Reporting of the Corrections of Excess SEP and SIMPLE Contributions.
IRS Publications 560 and 590 and Rev. Proc. 2006-27, which was subsequently amended, contain some limited information as to the treatment of excess SEP and SIMPLE contributions but such guidance is somewhat inconsistent and these publications would not normally be consulted for reporting guidance. Thus guidance with respect to the correction and reporting of distributions of excess deferrals and excess contributions needs to be substantially improved and expanded in the opinion of the IRPAC TE/GE Subgroup. As is, given the lack of guidance to the contrary, it is standard practice for IRA custodians to distribute excess contribution/deferral amounts from both SEP and SIMPLE IRA plans as non-taxable as in of Code Section 408(d)(4).
Proper reporting is further complicated by the fact that it is stated in IRS Publication 560 that excess SEP and SARSEP contributions are deemed to become employee IRA contributions except that the publication does not also indicate that such treatment would necessitate corrective reporting by the sponsoring employer to reflect the additional taxable compensation paid in the form of the employer SEP contribution treated as the employee’s own IRA contribution. In addition, some sponsoring employers believe they can change their minds about making a SEP or SIMPLE IRA contribution and demand that the IRA custodian return the contribution amounts to the employer on a tax free basis even though such amounts are not in excess of any limitation.
If there were explicit guidance in the Form 1099-R Instructions as to how to report the distribution of excess deferrals and excess contributions to SEP and SIMPLE IRA plans, what information IRA custodians need to obtain from plan sponsors or employees and what operational and reporting steps custodians should take with regard to requests for distributions of excess SEP and SIMPLE IRA deferrals and contributions (or change of mind contributions), custodians would be in a better position to more adequately and accurately report such distributions as taxable or non-taxable, as applicable, and be finally able to apply operational consistency.
Benefit to Payers
The TE/GE Subgroup believes that for all three items being addressed here, the benefit to payers is the existence of needed guidance which will enable improved compliance. Likewise clear and detailed guidance will serve to relieve the prevalent uncertainty as to how to report the transactions addressed and enable consistent reporting among payers.
Benefit to IRS
The TE/GE Subgroup believes that the provision or expansion and clarification of reporting guidance for the prospective rollovers to Roth IRAs once the $100,000 adjusted gross income (AGI) limit has been removed, IRA to HSA rollover transactions and distributions of excess deferrals and excess contributions to SEP and SIMPLE IRA plans would greatly enhance operational and reporting compliance and as a result substantially reduce potential underreporting of taxable income and thereby increase the collection of appropriate taxes by the IRS.
Benefit to Taxpayers
Just as with payers, it is assumed that the plan sponsors and affected employees want to comply with their reporting obligations and pay the proper taxes due, as applicable. If there were clear, concise and consistent guidance available on how to accurately report rollovers to Roth IRAs once the $100,000 AGI limit has been removed, IRA to HSA rollover transactions and distributions of excess deferrals and excess contributions to SEP and SIMPLE IRA plans and how to treat them from a tax perspective, it is strongly believed that compliance by both plan sponsors and affected employees would substantially improve.
C. Form 5500:
Alternatives to Electronic Filing:
The Form 5500 and its related schedules are used by the Service and the Department of Labor (DOL) to collect information regarding employee benefit plans. In addition, the Form 5500-EZ is used by the IRS to collect certain information from employee benefit plans that are not subject to the Employee Retirement Income Security Act. Beginning in 2009, most Forms 5500 must be filed electronically with the DOL. However, certain portions of the current filings, including Form 5500EZ and Schedule SSA for Form 5500 (Annual Registration Statement Identifying Participants with Deferred Vested Benefits), will not be filed electronically with the DOL. Instead, the IRS, as the agency responsible for collecting data for the Form 5500EZ and Schedule SSA, must determine other processes for plan administrators to submit the required information.
Form 5500-EZ Closing Agreement Program:
On March 28, 2002, the DOL introduced the Delinquent Filer Voluntary Compliance Program (DFVC) that provides for reduced penalties for late filing of Form 5500. However, filers of Form 5500-EZ or filers of the Form 5500 where there are no common-law employees participating in the Plan cannot use the DFVC program. Under DFVC, a plan pays a set penalty amount of $10 per day (up to a maximum of $1,500 for small plans and a maximum of $4,000 for large plans).
Late filers of Form 5500-EZ or filers of the Form 5500 with no common-law employees must pay a penalty of $25 per day up to $15,000 for the late filing of these returns unless reasonable cause is established. Because the IRS has not published any guidelines as to what may constitute reasonable cause, some late filers may be reluctant to file in situations where the penalties, if not waived, would be severe.
Alternatives to Electronic Filing:
The electronic filing requirement for Schedule SSA should not be burdensome to small filers. An analysis of recent Form 5500 filings would suggest that a few large filers report most of the participant names reported on the Schedule SSA. The analysis indicates that approximately 5% of the filers account for 85% of the participant names reported on Schedule SSA. Electronic filing of the Schedule SSA should be mandated for those filers who are responsible for the reporting the majority of participant names and a paper filing option should be available to filers who must report a relatively small number of participants.
The TE/GE Subgroup made several recommendations to IRS regarding the paper replacement for Form 5500-EZ and its instructions.
Form 5500EZ Closing Agreement Program:
The IRS should develop a closing agreement program for Form 5500-EZ and Form 5500 for plans with no common-law employees. The program should be patterned on the DOL DFVC program so that the delinquent filer program offered by the IRS would also provide for a reduced daily penalty amount and a significantly reduced maximum penalty amount.
Benefit to Payers, IRS and Taxpayers
Alternatives to Electronic Filing:
The recommendations regarding Schedule SSA will provide IRS with an efficient method to capture Schedule SSA information in a manner that is not overly burdensome to filers. The recommendations regarding the new Form 5500-EZ will make the form easier to use and should result in fewer erroneous entries.
Form 5500-EZ Closing Agreement Program:
A closing agreement program would benefit taxpayers by allowing them to become compliant with their filing obligations at a certain, modest cost. The program would benefit the IRS by increasing taxpayer compliance with filing requirements and providing the IRS with a better understanding of the universe of small owner-only plans. In addition, the closing agreement program may provide additional revenue to the IRS.
Alternatives to Electronic Filing:
As to the recommendations regarding Schedule SSA, the IRS has indicated that it is reviewing its statutory authority to compel electronic filing of Schedule SSA information. The IRS has already implemented the recommendations regarding the new Form 5500-EZ and instructions.
Form 5500-EZ Closing Agreement Program:
The IRS is currently investigating the feasibility of implementing a closing agreement program for Form 5500-EZ/5500.